Facing East: prospect of energy export from Russia to China

Polyakova Mariya Rafailovna Post-graduate student, the department of International Economic Relations, M. V. Lomonosov Moscow State University 125009, Russia, Moscow, Mokhovaya Street 11, building #1 mariarpolyakova@gmail.com

International economic cooperation becomes an intrinsic part of the development of modern countries. In forecasting the “increase” in economic growth each country seeks its own route ^[1]. In the conditions of political instability there is an ongoing restructuring of the global market as a whole, changing the situation in the economies of separate countries ^[2].

Lately, the countries of the Northeast Asia (in the geopolitical sense, the borders of the regions are not defined, and majority of the research include PRC, RF, Japan, North Korea, South Korea, Mongolia, and even Taiwan into this regions. Comment by the author) increasingly develop integrational processes in the region.But so far, it is mostly limited by interstate relations, and issues are resolved on the “one-on-one” basis between the neighbors. Moreover, there are no normative acts, agreements, or treaties that regulate the relations between all participants, which complicates the implementation of global projects in the region. For example, on the European territory during resolution of issues of energy cooperation, the countries use guidelines set by the European Energy Charter and the treaty thereof ^[3]. The question of necessity to create a similar document that would act on the territory of the countries of Northeast Asia has been repeatedly raised by the interested parties. However, it is a lengthy process that combines synergy of the analysis of the European experience and traditional Asian approaches. In any case, in order to regulate a specific integrational process it is important to understand its participants and their actual needs and abilities.

One of the integrational processes can be considered the work on uniting the power systems of the countries of Northeast Asia in to the “Asian Super Ring”. The research on this megaproject is being conducted for decades, and currentlythere are different points of view on how to realize it. One of the approaches is the first stage of development of bilateral relations and construction of energy bridges between the systems of two countries. Similar research is conducted by interesting companies, which are mostly guided by the economic efficiency and technical feasibility of specific projects.

One of the alreadyfeasible projectsis the supply of energy from the Russian Federation to the People’s Republic of China. The first long-term agreement in the history of Russia-China relationswas signed in 2012, supplying China with up to 100 billion kWh of energy over 25-year period. It is a known fact that energy is one of the base elements of any country’s economy, thus signing of such agreement between Russia and China specifically for this non-storable commodity speaks to the intention of both countries to work towards stronger economic ties and possibilityof strengthening integrational processes between the two countries.

Of course, the key questions are: who benefits from this “strengthening”; what position is held by each of the participants of these market relations; what are the potential possibilities. In this situation Russia acts as the seller, China as the buyer, and kilowatt hour is the unit of energy being sold. Let us examine why China with its own vast energy production needs this type of import.

It is evident that the current volume of energy export from Russia to China (2012 – 2.630 billion kWh, 2013 – 3.495 billion kWh, 2014 – 3.376 billion kWh, 2015 (9 mo.) – 2.5 billion kWh ^[4]) comprises only a small part of the consumption volume of energy in the bordering regions of the Northeastern China. For example, in 2013 the annual consumption of energy of the Heilongjiang province (where the energy is actually delivered to)consisted of 85 billion kWh ^[5], of which Russia supplied only 4%. At the same time, the existing power network allows to support a volume of approximately 6 to 7 billion kWh per year, which would have been 8%.

The current export volume of energy supplied within the framework of the acting agreement cannon significantly affect the economic indexes of the bordering Heilongjiang province, nor China as a whole, as well as it does not threaten the political and economic independence of China, especially taking into account that the energy industry of the People’s Republic of China is the largest in the world.The established capacity of the objects of generation according to the data from the early 2015 comprised 1.36 thousand GW ^[6]; the annual volumes of commissioning of the power generating capacities during the period of 2000-2014 comprised approximately 72 GW per year, and during the period of 2010-2014 they have reached 100 GW per year. This is considered the highest index on the commissioning of the power generating capacities throughout the entire history of the global energy industry. For example, 230 GW of the new generating capacity commissioned in China during the 2012-2013 matches the total established capacity of all combined power stations of Russia (232 GW)!

It would seem that from the perspective of the physics of the process, China does not really need the export of energy from Russia into the bordering region, but in this case an important role is played by simple math, or more precisely economics. According to the data of JSC “Inter RAO”, the size of export value in 2012 comprised 49 USD/MWh, and the price formula takes into account the price of wholesale market of Heilongjiang province ^[8]. Let us look at the energy prices on the China domestic market. The specificity of the price formation is a directive form of its establishment by the state agency (The National Development and Reform Commission of the People's Republic of China), in essence it is the rate. The liberalization of the China energy market is yet to take place, and currently the government itself sets rates throughout the entire country.In Russian the rates are applied only to the Far East territories.From the visual point of view, the energy rates in Russia are approved and published annually by the local regulators within the framework of the nationwide policy in the actual units of measurement, while in China the National Development and Reform Commission introduces changes into the already existing energy rate by provinces on the irregular basis, indicating just the extent of the changes. The analysis of these bylaws makes it possible to expertly calculate the energy rate, provided by the coal power plants in the Heilongjiang province in 2012. According to the Decision of the National Development and Reform Commission of China No. 2620 (2011), the rate on the energy and coal generation was established in the amount of 404.9 Yuan / MWh; the weighted average rate of the Bank of China in 2012 comprised approximately 1 USD per 6.24 Yuan. As a result, the rate equals approximately 64 USD / MWh (the presented expert assessment does not include the losses during energy transferring and other specific costs. Comment by the author). Having compared the aforementioned numbers, it is evident that for Heilongjiang province in 2012 buying the energy from Russia was 20% more profitable than producing energy on its own coal power plant.

Let us also expertly assess the economic profit from the sales for Russia under the conditions of the acting agreement. According to the Order No. 258 dated from 12.30.2011 by the Administration of State Regulation of Prices and Rates of Amur Oblast, the weighted average value of energy (capacity) without the losses and transferring comprised approximately 1295.27 RUR / MWh in 2012 ^[9] (In Far Eastern Federal Districtis applied the subsidization of the end users during the payment of power bills. Comment by the author). As reported by the Central Bank of the Russian Federation, the weighted average exchange rate of USD to RUR in 2012 equaled 31.07417 RUR to 1 USD, thus the energy value equaled 41.68 USD / MWh.This assessment demonstrates that in 2012 Russia had higher sale prices for China than for the domestic market, but at the same time, China was buying cheaper than would produce itself. And this is in the conditions of the pre-crisis prices and currency exchange rates. Supposedly, under the current economic situation, the seller’s profit would increase if the currency of the agreement does not change.

Today, the seller forecasts the annual volume of supplies at 3.5 billion kWh all the way until 2021. Namely such volume of export into China is included in the “Scheme and Program of Development of Unified Power system of Russia for 2015-2021”, established by the Order of the Ministry of Energy of the Russian Federation No. 627 from September 9, 2015. This delivery takes place using the active lines 110, 220, and 500 kW; the overall throughput of their sections totals at least 1,000 MW in nominal regime, in other words, it is able to transfer annually twice as more that it is stated currently.

Let us say that China is ready to import large volume of energy. What is Russia’s potential to provide and guarantee such increase? The stated volume of energy is planned to be taken from the wholesale market, i.e. the sale is based on the excesses that can be provided by this power system; but how can they be guaranteed, and what are the alternatives? For this purpose, let us more carefully examine the situation of the power systems bordering China.

Currently, the export of energy to China comes from the Amur power system, which is a part of the interconnected power system of the East (IPS East). The IPS East covers the largest part of the Far Eastern Federal District (FEFD), which has its southern border with China. In addition to the Amur power system, the IPS East also includes the power systems of Khabarovsk Krai, Jewish Autonomous Oblast, Primorsky Krai power system, and Southern Yakutia energy district, which in 2016 should also be joined by the formerly isolated Western and Central energy districts of the Sakha Republic (Yakutia). We should not forget that the energy complex on the territories of FEFD includes not only the IPS East, but also several other isolated power systems. In essence,the FEFD energy complex is the weakest link of Russia’s Unified Power System (UPS) that was practically untouched by the reforms. Even in the IPS East the energy transfers are limited by the network grid, which requires substantial modernization. As a result, we can notice a certain “tilt” in the balance: the west has a surplus, while east has a deficit. We should note that the problem of weak transfers in the IPS East currently benefits the organization of energy export from the Amur power system, which as we have already mentioned can be considered excessive, otherwise it would be problematic to setup export if it took place from the deficient Primorsky Krai power system.

In addition to the Far Eastern Federal District, China also borders the Siberian Federal District (SFD). Unlike the FEFD energy complex, the Siberian energy complex is consolidated into an interconnectedpower system (IPS Siberia). The Siberian IPS includes ten regional power systems: Altai, Buryatia, Chita, Irkutsk, Krasnoyarsk, Novosibirsk, Omsk, Tomsk, Khakas, and Kuzbass.

The IPS East is in essence the most remote and isolated territory from the central part of Russia. Transfer of energy from the IPS east is currently directed towards IPS Siberia and China, to which IPS East is connected.

IPS Siberia has a more favorable geographic location; it borders with IPS Ural, IPS East, and power systems of Kazakhstan, Mongolia, and China; it is one of the largest IPSs within the UPS Russia. However, IPS Siberia does not have connections with the Chinese power system,so setting up export of energy from IPS Siberia to China would require construction of new power network objects.

In order to determine potential possibilities of increasing the current volume of energy export, search for alternative means of its organization, as well as guarantee of its provision, it is important to consider not only the network grid, but also the structure of the set capacities on the territory of the regions in question.

At present, the structure of generating sources and IPS East and IPS Siberia is formed on the basis of hydroelectric and thermalpower plants.

The hydroelectric power plants of IPS East are concentrated only in the Amur power system, while the hydroelectric power plants of IPS Siberia are located in its southern region. The total set power capacity of the hydroelectric power plants of the IPS East equaled 3, 340 MW as of 01.01.2015 ^[10] or roughly 37% of the entire set capacity of the IPS East; in IPS Siberia – 25,271.4 MW and 49.6% respectively.

In IPS East the thermal power plants are located more equally throughout its territory than its hydroelectric power plants. The geographical placement of thermal power plants for IPS Siberia is similarly placed with its hydroelectric power plants, including in its southern part. As to the set capacity for the thermal power plants, IPS East totaled 63% or 5, 846.6 MW as of 01.01.2015, while IPS Siberia capacity totaled 50.4% or 25,699.9 MW respectively.

The reserve capacity of theIPS East is historically large due to the need to reserve the non-guaranteed capacity of the hydroelectric power plants in the Amur power system by the thermal power plants.The size of reserve capacity equaled approximately 9.06-4.6-0.68 = 3.78 GW (72% from the maximum load including export) during 2013-2014. Considering the standard reserve capacity (23% for 2014 from maximum load) necessary to ensure reliable functionality of the IPS East, practically above standard reserve capacity consisted of 9.06-4.6-4.6*0.23-0.68 = 2.72 GW.

At the same time, the high reserve capacity ~ 2.72 GW does not mean that this entire reserve can be used for expert (China, North Korea, South Korea, Japan) or covering the load from new consumers on the territory of IPS East without constructing additional generation. Production of energy at the hydroelectric power plants cannot be guaranteed throughout the entire year, as it depends on the volume of annual precipitation in the basins of the Zeya and Bureya Rivers. Therefore, considering the high portion of hydro power generation (approximately 30% in the balance capacity), in order to ensure reliable and quality power surveys for consumers during the drought years the thermal power plants must maintain higher reserve capacity.Naturally, in such situation export can take place only on the excess power, production of which is uneven, varying from day to day, as well as throughout the year. To ensure guaranteed expert supply from IPS East it is necessary to construct additional generating objects of thermal power.

IPS Siberia currently exceeds its set capacity. The combined capacity of the power plants equals 50.9 GW. As of 01.01.2015, its maximum load equaled 30.6 GW, with additional load from the export equaling 0.26 GW. The size of actual reserve capacity consisted of 50.9-30.6-0.26 = 20 GW (64% of the maximum load including export). Taking into consideration the standard reserve capacity (22% as of 2014 from the maximum load) necessary to ensure reliable functionality of IPS Siberia, the above standard reserve capacity consisted of 50.9-30.6-30.6*0.22-0.26 = 13.3 GW. The high amount of reserve, same as with IPS East, is justified by the need for the thermal power plants to reserve the non-guaranteed capacity of the hydroelectric power plants, the portion of which in the balance capacity comprises approximately 50%.

As in the situation with IPS East, the high amount of reserve capacities ~ 13.3 GW (50.9-37.6) within the interconnected power system of Siberia does not mean that the entire reserve can be used for the purposes of export (Kazakhstan, Mongolia, China) or coverage of the load from the new consumers on the IPS Siberia territory without constructing additional objects of power generation. It is worth noting that IPS Siberia has the possibility of export of power into the central part of Russia, which is especially relevant during the period of high water levels in the reservoirs of the hydroelectric power plants. Transportation of capacity via transit linesof power transfer “Siberia – Ural – Center” can reach to GW. However, according to the 2014 data ^[11], the existing transit was used predominantly not for export, but for import of 1.72 billion kWh of power from the Ural power system, which testifies to the lack of additional export potential of the IPS Siberia.

Thus, in order to ensure steady export from IPS Siberia, same as in the case with IPS East, it is necessary to construct additional generating objects.

Construction of new generating objects and network grid is necessary for both power systems. This is primarilydue to significant wear of equipment of the thermal electric power plants (over 60%). A serious road block for the development of new construction in power generation, with consideration of the economic efficiency of the projects, is low throughput of the existing power grid, which we have already mentioned earlier. The low throughput and the resulting limitations of the system in building reserves define the limit for single capacity of new power blocks, in turn making the projects more costly.

It is evident that further development of the topic of guaranteed export of energy is only possible with construction of new efficient thermal power plants. Production of powerby the hydroelectric power plants has a seasonal nature; moreover, the low cost can only be discussed with consideration of production at the already functioning hydroelectric plants. Currently, new generating objects should be considered as investments, thus the importance falls onto the feasibility of the new construction. One way or another, a significant impact in the assessment of the economic efficiency lies in the price of energy and capacity.

Electricity market was formed as a result of the conducted reform of the energy industry. Russia’s wholesale electricity market functions within two price zones: the first zone is comprised from the territories of the European part of the Russian Federation and Ural, the second is Siberia. Thus, the Siberian power system functions within the second price zone of the electricity market.

The FEFD territory however, as we have already mentioned earlier, was not part of the energy reform. Therefore, the price point is set for the thermal and hydroelectric power by the local and federal regulatory branches. The rates for thermal energy are set by the local regional energy commissions based on the justified level of expenses to produce and transfer thermal energy. The rates for hydroelectric power are set by the Federal Tariff Service. At the same time, there is a mechanism of inter-territorial subsidies on the territory of IPS East, according to which the energy prices are set equally for consumers of all power systems of IPS East.

As the result of a large portion of cheap hydroelectric generation (more than 30%) in the balance of energy, the rates for power in IPS East as a whole match the prices for energy in Russia, while in IPS Siberia with the introduction of a competitive pricing and significant portion of inexpensive hydroelectric generation, the energy prices are substantially lower than prices within the European part of Russia, Ural, and Far East.

For example, in 2013 the average price for energy in IPS Siberia amounted to approximately 1.9 rubles per kWh, which is roughly 34% lower than in the IPS East (2.9 rubles per kWh), where there is a successful energy export project to China.

In the current situation in IPS East and IPS Siberia, to significantly increase the volume of energy export seems highly unlikely. Construction of new generating capacities, especially export-oriented, and the corresponding network power grid would require private investments. Unfortunately investment attractiveness of IPS East and IPS Siberiaremains fairly low, even with consideration of the conducted reforms. Inflow of private investors into energy industry is limited by a number of factors, among which the most characteristic for IPS East are:

1. Absence of a mechanism for accessing the market, where a monopolistic position is held by the state-owned companyPJSC “RusHydro” and its sister company PJSC “RAO Energy Systems of the East”.
2. Absence of mechanisms that would ensure return on investments with guaranteed returns. At the same time,in the reformed part of the industry such mechanisms were introduced in the generating sector on the basis of agreements on provision of capacity, as well as in the power grid complex via introduction of RAB regulations (Regulatory Asset Base or regulated base of active capital – the size, set for the purposes of tariff regulation, which reflects the market value of company assets with consideration of their physical wear. Comment by the author).
3. State tariff regulation of thermal and electric power for thermal power plants in the conditions of competitive pricing for fossil fuels. The price for natural gas for the generating objects of IPS East is regulated by the state, except for the objects located in Khabarovsk Krai; the price for natural gas for these objects depends on the ruble to U. S. dollar exchange rate.
4. Absence of experience in establishing sufficient amount of expenses for generating thermal and power network companies for modernization and new construction with confirmation of rates for thermal and hydroelectric energy.
5. Absence of competition between companies; lack of stimuli for energy conservation, and increasing of technological and operational efficiency.
6. Low portion of industrial production, which explains the high inequality in daily energy consumption schedule, often requiring suspending or starting the main equipment of the power plants. Such nature of the work schedule leads to vast additional expenses, which in turn increases the production cost and decreases profit.
7. The state still controls energy companies on the territory of FEFD, continuing to finance large investment projects in the sphere of energy, as well as issue subsidies on the regional and federal levels.

On the territory of Siberian Federal Okrug there is also number of unresolved issues that impede attraction of additional investments in IPS Siberia:

1. All constructed generation objects are being built within the framework of agreements on provision of capacity. The new objects, both, new construction and reconstruction, do not have a mechanism for ensuring return on investments in construction or reconstruction of generating objects.
2. In the current pricing formation ^[12], as well as limitations on development of their own generating objects ^[13], outside investors are practically unable to construct generating sources even for maintenance of their own industrial capacities. The sector of distributed generationis virtually not developing. The ability to operate on the market belongs only to participants that joined the industry at the stages of reform.
3. Due to high portion of cheap hydroelectric energy, the energy prices in Siberia are almost twice as lower than in the European part of Russia and Ural. This means that with the same expenses for construction of new generating objects the profitability of such project in Siberia will be twice as lower than in the European part of Russia or in Ural. Considering the aforementioned circumstances, this factor makes the Siberian power system most unattractive for investments out of all reformed power systems.
4. Despite the introduction of RAB regulation, the distributed power networks are still not transferred to management of any private company as it was originally presupposed. As a result, the investments into the energy complex were attracted, but the efficiency of their use remained on the same level.
5. There is still state tariff regulation of thermal energy for thermal power plants in the conditions of competitive pricing for fossil fuels.

The above factors significantly limit development of IPS East and IPS Siberia as a whole, and it especially affects construction of generating objects oriented exclusively towards domestic market. One of the purposes for the energy reform in Russia was attraction of investors into energy ^[14]. Construction of export-oriented projects can increase investment attractiveness, since foreign companies, including China’s, will be interested in guarantees of provision of energy from such plants, and for them participating in the capital can serve as the guarantee. Such approach may become the starting platform for global changes in the situation with attraction of foreign investors into the region, especially since there is potential for development.

Growing its own export potential in the energy sphere will allow Russia to introduce quality changes into the structure of trade balance between Russia and China with regards to energy resources, strengthen the existing energy complex of Russian regions bordering China, and thus lay the foundation for increasing energy efficiency of the electrical grids and generating objectsin the east of the country ^[15]. It will also stimulate development of related industries, for example, increase the level of localization of production of energy equipment on the Russian territory, create new jobs in the regions, grow the tax base in the regions, as well as introduce quality changes into the structure of trade balance between Russia and China with regards to energy resources.